An NYU MBA student asked an interesting question during the three-hour class's break:
Q: Why does it matter to society, to an executive or to shareholders if a company goes bankrupt or is successful? Also, why does it matter to a society or to an executive if your side wins in a war?
A: With respect to society, a common economic concept of efficiency is "Pareto optimality" named after a Swiss sociologist. "Pareto optimality" describes a situation where you can't make someone better off without making someone worse off. Winning a war is not Pareto optimal since it is win/lose or distributive. Of course, society has an interest in winning a war because winning enhances national welfare and security. In prior epochs imperialism meant that wealth was secured in this way, and that may still be true. But from the viewpoint of the Almighty, it may not matter who wins the war since one side is worse off, i.e., there is no Pareto optimality, although of course there is such a thing as a just war, although each side would argue for it.
However, unlike in military or government contexts, in economies firms can create wealth without taking from anyone else, just as Standard Oil or Wal-Mart have, even if some will argue that they have done so in a non-Pareto-optimal manner. A firm like Apple invents the PC, and we are all better off or wealthier. Thus, capitalism maximizes social welfare. Social wealth corresponds to increase in shareholder value where there are no externalities and no government subsidies. However, if firms depend on subsidies, for instance Federal Reserve credit injections, then their maximization of shareholder value cannot be said to maximize social welfare.
The question is sometimes different with respect to social outcomes. The economist Ronald Coase noted that in a world with no legal* costs, alternative legal rules will result in socially optimal outcomes regardless of whether they favor one side or the other. The reason is that if a rule favors side (a) but optimality requires that side (b) act while harming side (a), side (b) can act only where the profit is sufficient to cover a liability payment to side(a) (again, this will occur where there are no legal costs inhibiting side (a)'s legal case). Thus, side (b) will act just as it would as if the legal rule favored it rather than side (a). Where the losses are too great to cover the legal payment, (b) will act just as they would were they suffering the losses themselves. Thus, socially optimal behavior will occur in this (non-existent) case of zero legal costs of pursuing compensation whether side (a) or (b) suffers the losses. However, that does not depict the real world where there are legal costs.
In general, though, in a free market system, a firm's maximization of profit means that it is also maximizing social welfare. This will not occur if the externalities that the firm produces exceed the value that the firm creates. A perfectly efficient economic system will require that firms that cause externalities (pollution and the like) pay for them out of profit. Efficiency can conflict with economic growth, then.
Here is my question to the class:
The point of maximizing shareholder goals is somewhat different from social optimality. A legal and moral concept describes the duty of a corporate official to aim to maximize profits. It parallels an even more basic legal and moral principle that says that generals and military commanders must aim to win a war.
What legal concept am I describing (a) with respect to corporate officials and (b) with respect to military commanders?
*the technical term used is "transactions" costs rather than "legal" costs, but the terms are closely related.
